Small and medium-sized enterprises’ (SMEs) access to finance took a dramatic hit during the financial crisis and subsequent recession. The small business lending environment has improved since then, however. The rate of decline in the stock of SME lending slowed from 2012 onwards, evolving into positive annual growth from 2015. It achieved 2.1 per cent in September 2016. In fact, 2015 saw growth in a variety of types of finance for SMEs, including flows of both equity and debt finance, asset finance volumes and new equity deals. Between 2015 and 2016, 81 per cent of all SMEs that applied for a loan or overdraft were successful, increasing from 69 per cent between 2011 and 2012.

In addition, a lower proportion SMEs view access to finance as a barrier to running their business, declining from 11 per cent of SMEs in 2012 to 5 per cent in the first two quarters of 2016. In a list of potential barriers, access to finance was ranked sixth in importance by SMEs respondents, behind the economic climate, regulation and political uncertainty. It was ranked fourth in 2012. Access to finance has clearly become less of an issue for SMEs.

However, many small businesses applying for finance are still being rejected. According to survey evidence, almost 100,000 SMEs and approximately £4 billion worth of applications for debt are rejected each year. There is clearly a funding gap (the difference between the funding required by SMEs and the funding available). In 2013 the National Audit Office suggested that there was a funding gap of between £10 billion and £11 billion. According to the British Bankers’ Association, estimates of the gap range from a few hundred million to over £30 billion. Finding an exact value for the gap is very problematic because it is difficult to measure some of its aspects, including discouraged demand for finance amongst SMEs. However, the evidence overwhelmingly points to the existence of a large funding gap.

There are three types of SMEs that have found it particularly difficult to access the finance they desire: very small businesses, those with a worse than average risk rating and start-ups. For example, 66 per cent of businesses with zero employees, 52 per cent of those with a worse than average risk rating, and 45 per cent of start-ups were successful in their loan application between 2015 and 2016. This differs drastically with the number of large SMEs (97%), those with a minimal risk rating (98%), and those seeking a renewal (100%) that were successful. Overdraft applications follow the same pattern.

According to the British Business Bank, a fair proportion of SMEs that do not obtain external finance are actually viable businesses, turned down due to failures in the access to finance market. A variety of market failures exist, but one is especially poignant. SMEs, especially riskier SMEs that are usually small and young, are less likely than bigger businesses to have the information required by lenders to make an informed investment decision, including a lack of credit history or trading record. This lack of information makes it difficult and costly for the lender to assess the SME and subsequently extend finance, even if the SME is a viable business. It can also lead lenders to ask for large levels of collateral that the SME simply does not have. As a result, the lender’s funds are usually driven towards larger and less risky firms that are easier to asses and away from viable SMEs.

Since the financial crisis, banks have become particularly risk averse. Riskier but viable SMEs have therefore found it particularly difficult to attain finance from banks. It does not help that SMEs are overly dependent on bank finance. Between 2010 and 2015, bank lending accounted for approximately two-thirds of the post-crisis increase in gross funding to SMEs. In 2015, 29 per cent of SMEs used a bank overdraft, bank loan and/or credit card, overshadowing any other type of finance, including non-bank loans (6 per cent) and equity finance (2 per cent). The lack of alternative finance options mixed with the risk-averse nature of banks has made it difficult for some types of viable SME, especially small start-ups and those with an inadequate credit history, to get the finance they need.

This is a huge problem because SMEs are vital to the UK economy, making up 99.9 per cent of all private sector businesses, 60 per cent of private sector employment and 47 per cent of private sector turnover. The types of SMEs being rejected make up a significant proportion of the SME sector: 49 per cent of SMEs have a worse than average credit rating and 96 per cent of businesses in the UK are small, employing between zero and nine people. Their lack of finance is resulting in lost output, employment and economic growth.

The funding gap needs to plugged. This cannot be achieved by bank lending alone. Requiring banks to extend finance to the risky SMEs would not be sensible, and the variety of products required by the smallest SMEs could not be delivered efficiently by one type of provider. According to the Federation for Small Businesses, ‘banks cannot be expected to design and provide products and services to meet the needs of all types of smaller businesses.’ Instead, other finance providers are required to help plug the funding gap. Responsible finance providers (RFPs) are one such provider.